IRS Resists Whistle-Blowers Despite Wide U.S. Tax Gap

Alliantgroup LP is a politically
connected advisory firm that helps companies apply for lucrative
tax credits. Clients have ranged from Oscar de la Renta to an
Arkansas candle maker.

The firm also helps companies sidestep taxes, two former
employees alleged in July 2009. In a 32-page submission filed
with the Internal Revenue Service, along with internal e-mails
and documents, they claimed Alliantgroup’s clients could owe the
U.S. Treasury as much as $712.5 million in refunds over wrongly
claimed tax credits. The whistle-blowers stood to make more than
$210 million, under a law that offers informers as much as 30
percent of what the government recovers from their tips.

Twenty-one months later, the IRS rejected the claim,
without its auditors ever talking to the whistle-blowers and
even after a request by some agents to convene a grand jury,
internal agency documents show.

The IRS whistle-blower program -- created by Congress in
2006 to boost tax revenue by giving incentives to tipsters --
has become the place where allegations of tax avoidance go to
die. Over the past five years, more than 1,300 claims have been
filed against almost 10,000 companies and individuals, alleging
tax underpayments of at least $2 million apiece.

Just three awards have been paid. The IRS won’t disclose
the total dollar amount. Taxpayers annually owe $385 billion
more than the IRS is able to collect, the agency said.

Tipsters Unwelcome

By contrast, the U.S. Treasury has recovered more than $21
billion since 1986 due to whistle-blower tips under a similar law
that covers other federal agencies. Last month, the Department
of Justice announced that Abbott Laboratories (ABT) would pay $1.5
billion to settle federal and state claims that it illegally
promoted an anti-seizure medication. Information from four
whistle-blowers helped prompt the investigation.

The IRS is “demoralizing whistle-blowers” Senator Charles Grassley, who sponsored the whistle-blower law, wrote to Treasury
Secretary Timothy F. Geithner in April. “The IRS does not have
a problem attracting whistle-blowers. The IRS’s current problem
is processing and compensating whistle-blowers in a timely
manner,” said Grassley, an Iowa Republican. As a result, “I am
now concerned that whistle-blowers will stop coming forward.”

Even as the U.S. grapples with a $1.2 trillion budget
deficit, the IRS won’t aggressively pursue whistle-blower tips
because of fears that will spur accusations from Congress of
heavy-handed enforcement, said Bryan Skarlatos, a tax-litigation
lawyer at Kostelanetz & Fink LLP.

Lengthy Process

Whistle-blower claims “can take years to go through the IRS
review and award determination process,” and the IRS doesn’t
collect enough information on why claims are rejected, the
Government Accountability Office said in a report last year.

The program hasn’t met expectations, IRS officials said.
“It’s fair to say the whistleblower program isn’t where we
would like it yet,” said Steven T. Miller, IRS deputy
commissioner for services and enforcement, who oversees the
whistle-blower office. “And I think it’s fair to say we are
working hard on it.”

The IRS doesn’t talk to whistle-blowers more frequently
because of concerns about violating strict laws protecting
taxpayer privacy, Miller said. He attributed the slow pace to
taxpayers appealing IRS rulings. The agency says prospective
whistle-blowers should expect to wait as long as seven years
for an award.

“It is not an incredibly fast process,” Miller said. The
agency expects to pay out another three to five awards this
year, he said.

Filed Confidentially

Whistle-blower allegations are filed confidentially and the
IRS never tells the subject that a claim exists. Informed of the
allegations by Bloomberg News, Alliantgroup denied them.

Alliantgroup is “proud of its success in helping thousands
of small and medium businesses across the country benefit from
tax credits and incentives,” the company said in a statement.
Alliantgroup’s directors and advisory board include a former
senator, three former congressmen, a former IRS commissioner and
several former congressional tax-staff members.

Spurned whistleblowers include a California environmental
activist, John Hansen. He filed an IRS whistle-blower submission
that claimed the value of salt flats sold by Cargill Inc. had
been exaggerated by appraisers, inflating charitable donation
deductions. A California judge found the property’s appraiser
had overvalued the land.

While the IRS reduced Cargill’s deductions, it rejected
Hansen’s claim without speaking to him even though he had more
information, Hansen said. Cargill accepted the IRS’s reduced
deduction, said Lori Johnson, a spokeswoman for the agriculture
company.

Odyssey Begins

The Alliantgroup whistle-blowers’ odyssey began in July 2009
when they submitted their claim to the IRS.

The ex-employees permitted Bloomberg News to review their
allegations and requested anonymity because the IRS doesn’t
disclose whistle-blowers’ names. One of them works for a firm
that advises companies on tax credits. The two former employees
spent a combined six years working at Alliantgroup’s
headquarters in Houston; one is a tax attorney.

The IRS has challenged research credits claimed by some of
Alliantgroup’s clients.

In March, U.S. Tax Court Judge Diane L. Kroupa rejected tax
credits by an Alliantgroup client and said the firm had shown no
proof that wages paid to two top executives of hair-care
products maker Farouk Systems Inc. qualified as research
expenses.

‘Self-Serving’

“The inadequate substantiation prevents any amount of the
relevant wages from qualifying for the research credit,” the
judge wrote. She called the testimony from Farouk’s witnesses
“self-serving and unreliable.”

While Alliantgroup said in a statement that Judge Kroupa’s
findings were “unfortunate,” it said “there is no question”
that Farouk Systems’ founder and employees engaged in research.

In the whistle-blower claim, the former employees alleged
Alliantgroup inflated research expenses by saying top managers
spent large portions of their time working on such projects.
That enabled more of their salaries to count as costs eligible
for the credit.

The whistle-blowers included an internal e-mail that showed
-- after the IRS began examining one client -- Alliantgroup
manager Amol Gavankar suggested changing the job description of
a purchasing manager.

“Obviously in software design, purchasing has no
qualification in R&D,” Gavankar wrote. “I need you to decide
whether we should modify the title or figure out a better job
description.”

Job Descriptions

In an interview, Gavankar, who left the company in 2008,
said that while he didn’t recall the specific e-mail exchanges,
it was common to shoehorn employees’ job descriptions into
positions that would help generate credits.

“I wasn’t comfortable with that,” he said. “Not having a
formal tax background, we did what the partners taught us to
do.” Gavankar previously worked as a software engineer.

“Alliantgroup does all it can to provide accurate job
titles to the IRS,” the company said in a statement. Clients
must “provide confirmation of allocations and costs before
information is placed into” their studies. The company says 93
percent of the research credit dollars claimed by clients and
audited by the IRS or state tax administrators since January
2009 have been upheld.

Overworked Auditors

In August 2009, a week after receiving the whistle-blowers’
file, Katherine Onken, an IRS analyst, began working the phones.

The 35 staff members in the IRS whistleblower office don’t
pursue claims themselves. Instead, they try to enlist overworked
auditors on the IRS’s enforcement staff, whose ranks dropped by
more than 500 agents and revenue officers last year.

Reached by telephone, Onken declined to be interviewed.

Onken learned the IRS had previous disputes with
Alliantgroup’s clients. Agency officials in Houston “have had
many cases with this group,” according to an e-mail to Onken
from a colleague on Aug. 10, 2009. She also found out
Alliantgroup was in negotiations with the IRS over a proposed
penalty of about $250,000 for allegedly preparing false tax
returns. The company says it hasn’t paid any penalty.

In November, three months after filing their claim, the
whistle-blowers hadn’t received any IRS response, other than an
acknowledgement it was received. Their attorney, Joel Androphy,
arranged a meeting with two agents from the IRS’s criminal
division in Houston.

The meeting lasted the better part of a day. The IRS agents
started a preliminary investigation into Alliantgroup and
requested the convening of a grand jury, according to an
internal agency memorandum from Jan. 5, 2010.

Request Denied

That request was denied after discussions between the
criminal division and the IRS chief counsel’s office, according
to the memorandum. The file was passed back to Onken at the
whistleblower office.

On the same date, Onken e-mailed a description of the
allegations to her boss. The whistle-blower office’s director,
Stephen Whitlock, wrote back quickly that there might be a case
to be pursued against Alliantgroup.

He also cautioned in an e-mail: “Sounds like this would be
very resource intensive.”

Alliantgroup’s political connections were also raised in
several internal IRS memos.

Alliantgroup’s vice chairman is former IRS Commissioner
Mark W. Everson, who ran the agency under George W. Bush from
2003 to 2007. Its national managing director is Dean Zerbe,
former senior counsel to the Senate finance committee, who
worked for Grassley and helped write the legislation that set up
the whistle-blower office. He has represented several tax
whistle-blowers, including former UBS AG banker Bradley Birkenfeld.

Keeping Tabs

Everson and Zerbe keep tabs on federal tax developments and
update the company’s clients on potential changes and
legislation.

Following a conference call on the allegations about
Alliantgroup, Onken, the IRS analyst, scrawled one word next to
Everson’s name in a handwritten memo: “Concern.”

That concern was heightened in May 2010 when Onken received
a phone call from her boss, Whitlock. He told her Zerbe and
Everson were meeting with the IRS later that week, according to
Onken’s notes. “He didn’t know what the topic/purpose of the
mtg was,” she wrote.

Everson and Zerbe met with five top officials at the IRS
that month, an agency spokeswoman said, including Commissioner
Douglas Shulman and Miller, the deputy commissioner for services
and enforcement.

Presenting Views

The meeting was requested by Alliantgroup to “present its
views of issues and challenges faced by small- to mid-sized
accounting firms,” said an agency spokesman. It didn’t address
the whistle-blower office, the agency said.

The IRS’s “determination of any case is based on the law
and the facts as they are presented -- period,” said Terry Lemons, an IRS spokesman. “Our agents are trained to avoid any
inappropriate influence by a taxpayer’s representative. We have
multiple reviews in place throughout the IRS to ensure decisions
are based solely on the facts and circumstances of the case.”

Meanwhile, the Alliantgroup file had been given to an IRS
technical adviser. While he dismissed some of the allegations, a
few were “troublesome,” he wrote. They included the
allegation that Alliantgroup changed job titles of clients’
employees to qualify for more research tax credits.

‘Intentional Act’

“The changing of job titles and use of generic
descriptions seem at first glance to have been an intentional
act to disregard of [sic] the rules,” wrote the IRS official,
Paul Coates in his May 20, 2010 memorandum. He recommended
passing on those allegations to field agents and said a penalty
against the firm may be warranted.

Nevertheless, analysts and examiners whose job it is to
audit companies like Alliantgroup resisted pursuing the
allegations. A team already auditing Alliantgroup as part of a
broader examination of research tax credits “doesn’t want to
look at the [whistle-blower] info because they think they have
the same or similar info,” Onken wrote in a June 2010 memo.

“I don’t understand why the team wouldn’t want to look at
the info,” Onken wrote.

Soon after, one of the whistle-blowers called Onken to say
he still hadn’t heard back from the IRS, a year after filing his
claim. She said she couldn’t tell him anything other than that
his claim was being considered, according to her notes of the
conversation.

IRS Reluctance

The reluctance of the IRS to talk directly to
whistle-blowers is common, according to lawyers who file such
claims.

“You have an agency that is virtually completely non-
communicative,” said Erika A. Kelton, an attorney at Phillips &
Cohen LLP in Washington, which represents about 40 tax
whistle-blowers. Since sophisticated tax shelters are complex,
“when you have an insider who can shortcut things for you, why
not take him up on it?”

The IRS generally doesn’t permit its most knowledgeable
examiners -- field agents handling audits -- to speak to the
whistle-blowers at all, the agency says. That is because of fears
of accidentally sharing confidential information with
whistle-blowers, said Marty Basson, an attorney who retired last
year from the IRS office that handles those claims.

As the agency debated what to do about Alliantgroup, one
IRS official expressed misgivings, according to internal
correspondence.

“On one hand it makes sense to reject” the claim, wrote
manager Amy Liberator in a June 16, 2010 e-mail. “On the other,
they’re (Alliantgroup) getting just what they want because they
know we probably won’t audit these mid-size” companies.

Liberator declined to comment.

Broader Issues

An IRS analyst who had been looking at the broader issue of
abuses of research tax credits -- identified by the IRS in 2007
as a top audit priority -- wrote in a memo that he didn’t feel
pursuing the allegations against Alliantgroup “would be an
efficient use of resources.” Onken forwarded this information
to her bosses.

A few months later, on April 26, 2011, the IRS sent brief
rejection form letters to the whistle-blowers.

“Although the information you submitted did not qualify
for an award,” it read, “thank you for your interest in the
administration of the internal revenue laws.”

The two whistle-blowers have filed a petition, under seal,
in U.S. Tax Court challenging the rejection of their claim.

“This could have been used to refund other taxpayers, or
pay down the national debt,” said one of them, the former
Alliantgroup tax attorney. “Instead, the IRS completely dropped
the ball. They wouldn’t spend the time and money to go after
it.”